GBP risk reaches lowest level since Brexit vote; Portfolio risk declines as FX/equity correlation weakens

Week of May 12

This week we take a look at how the predicted exchange rate volatility for GBP/USD declined to levels last seen before the Brexit vote in June 2016. Short-horizon risk for the pound now stands at 9.76% as of Friday, May 12, compared with 10.44% on the day UK voters decided to the leave the European Union.

The risk reduction came during a week in which sterling lost more than half a percent versus the greenback after a slowdown in UK industrial production was announced on Thursday. Even the hawkish tone struck by the Bank of England on the same day did little to support the currency. In its statement following the decision to keep interest rates on hold, the Bank noted that it may be necessary to tighten monetary policy to a greater degree than markets expect.

We also observed how short-term risk in Axioma’s global multi-asset class model portfolio decreased by another 0.72% to 3.49% during the week ending Friday, May 12, 2017. When looking at contributions by asset class, the risk reduction seems to have primarily come from the equity portion of the portfolio. While some of this was certainly due to lower standalone volatility of US stocks, most of the decline was driven by a decrease in correlation between equity returns and exchange rate movements.

In previous weeks, we observed a slightly positive relationship between stock markets and FX rates versus the USD. The fact that European currencies and shares around the globe rallied after the relief of the French election results translated into a higher risk contribution from both US and non-US equities. With stock returns and exchange rate motions now showing a much weaker correlation, this effect is less pronounced, leading, in turn, to lower overall portfolio risk.

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Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta.